David Hume on America’s public debt dilemma 

American government debt has been compounding for twenty years. When Bill Clinton left office, the budget was in balance. Since then his successors have tipped the scales. George W Bush had his hands forced by 9/11, Barack Obama by the crash of 2008, and Donald Trump by the pandemic. Joe Biden, too, cannot apply fiscal restraint. But questions will be asked, sooner or later, how he is minded to deal with the legacy of debt he inherited.

States get rid of debts in three ways: inflation, taxes, or default. On the eve of a new administration taking office, forecasters have been limiting their focus to the first two. The third option, default, is considered anathema. 

In 1760, David Hume in his essay Of public credit compared the benefits of all three of these options; his line of reasoning is as up to date now as it was then. Hume remarked that governments were forced to borrow in times of war but that in periods of peace, debt redemption was postponed:

“Our modern expedient, which has become very general, is to mortgage the public revenues, and to trust that posterity, during peace, will pay off the incumbrances contracted during the preceding war: And they having before their eyes, so good an example of their wise fathers, have the same prudent reliance on their posterity; who, at last, from necessity more than choice, are obliged to place the same confidence in a new posterity.”

Governments that noticed they could take their time with debt redemption were tempted to try out a new approach that looks very much like what today passes for Keynesian fiscal pump-priming:

“According to ancient maxims, the opening of the public treasure, as it produced an uncommon affluence of gold and silver, served as a temporary encouragement of industry…What then shall we say to the new paradox, That public encumbrances are, of themselves, advantageous, independent of the necessity of contracting them; and that any state … could not possibly have embraced a wiser expedient for promoting commerce and riches, than to create funds, and debts, and taxes, without limitation?”

Hume formulated supply-sider objections:

“The taxes which are levied to pay the interests on these debts, are a check upon industry, heighten the price of labour, and are an oppression of the poorer sort.”

Weighing the alternative merits of these approaches, Hume, invoking a rationale that anticipates public choice theory, opined it was moot to expect that any government could be expected to repay debt: 

“Why therefore should a minister persevere in a measure so disagreeable to all parties? For the sake, I suppose, of a posterity which he will never see, or of a few reasonable reflecting people, whose united interest, perhaps, will not be able to secure him the smallest borough in England. ‘Tis not likely we shall ever find any minister so bad a politician.”

Hume’s conclusion was that “it may not be difficult to guess at the consequences. It must, indeed, be one of these two events: either the nation must destroy public credit, or public credit will destroy the nation.”

It needs no pointing out, that David Hume’s reasoning was timeless, if somewhat fatalistic. But what matters more in the context of assessing debt policy today, is that Hume offered pragmatic advice on policy options. Hume understood the two prescriptions urged today, namely higher inflation or higher taxes.  Both had been tried and tested:

“Some neighbouring states practise an easy expedient, by which they lighten their public debts. The French have a custom (as the Romans formerly had) of augmenting their money; and this the nation has been so much familiarised to, that it hurts not public credit, tho’ it be really cutting off at once, by an edict, so much of their debts. The Dutch diminish the interest, without the consent of their creditors; or, which is the same thing, they arbitrarily tax the funds as well as other property… But people in this country are so good reasoners upon whatever regards their interest, that such a practice will deceive no body; and public credit will probably tumble at once by so dangerous a trial.”

David Hume was not an advocate of unrestrained government borrowing, quite the contrary, and given his opposition to deficit spending, it may seem surprising that he gave his blessing to a step that in the present time to most politicians seems unthinkable, namely debt default. For Hume, given that debt service benefits only a minority of the citizenry, default confers benefits to the majority that outweigh the harm inflicted on the few: 

“Thousands are hereby sacrificed to the safety of millions.”

Returning to the context of the United States, debt default may sound unpalatable as well as far-fetched. However, there have been US precedents. 

Nine states of the Confederacy stopped debt service after the Civil War. And defaults occurred in states also for reasons other than war. In 1837 the State of Michigan issued bonds, but the proceeds from this issue did not reach the state’s treasury due to a bank failure. In 1857 the State of Minnesota issued bonds to fund expansion of the rail network, secured with mortgages on tracks which, when the railroad company failed, proved to be worthless, and contending claims of the state and of bondholders occupied courts and legislatures until 1881.  In the cases of Michigan and Minnesota, bondholders were never made whole.

To our current experience, these instances of states’ defaults may seem remote. Yet the causes triggering these defaults – war, failed investments, and financial malfeasance – were the same that have been afflicting US finances for the last twenty years.

David Hume’s prognostication that governments and debts cannot survive together indefinitely may seem dispiriting. If his insight into politics was astute but gloomy, on the other hand, his appreciation of human psychology was shrewd and cheering:

“So great dupes are the generality of mankind, that, notwithstanding such a violent shock to the public credit, as voluntary bankruptcy in England would occasion, it would not probably be long, ere credit would again revive in as flourishing a condition as before. “

For now, public attention is preoccupied with health policies. But a vigorous debate is due over the dilemma facing fiscal policies. It is futile to imagine this issue will evaporate of its own accord. How the Biden administration resolves these questions may well decide how his legacy is assessed in four years’ time.

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